Quirch Inc. manufactures machine parts for aircraft engines. The CEO, Chucky Valters, was considering an offer from a subcontractor who would provide 2,400 units of product PQ107 for Valters for a price of $150,000. If Quirch does not purchase these parts from the subcontractor it must produce them in-house with the following costs:

Cost per Unit:

DM 31

DL 18

Variable Overhead 9

Supplier's quotation (2,400 x $6.25) 150,000

Less: Relevant cost of production:

Direct material (2,400 x $31) 74,400

Direct labour (2,400 x $18) 43,200

Variable overhead (2,400 x $9) 21,600 139,200

Savings 10,800

The parts should be produced in-house since the relevant cost of production is lower than supplier's quotation.

Explanation:

In this case, we need to compare supplier's quotation to the relevant cost of production. The price of $6.25 above was computed by dividing the total price charged by the supplier by the number of parts. Moreso, the relevant cost of production is obtained by the aggregate of direct material, direct labour and variable overhead.